Elliott Wave | WaveTrades Elliott Wave A Aggregate: Any Elliott Wave pattern formed by the co-joined collection of separate wave sequences (opposite or antonym of ‘component’) e.g. a zig zag – itself composed by three separate waves, A-B-C co-joined to form the pattern. Alternation: If wave two is a sharp correction, wave four will usually be a sideways correction, and vice versa. Alternate Count: An alternative assessment of a wave pattern that complies less to various rules and guidelines than the ‘preferential’ count as applied to The Wave Principle. Apex:Intersection of two converging boundary lines of a contracting triangle. B Basic motive pattern of the Elliott wave principle, how price moves not in a straight line but in a series of rises and retracements. C Channel: The technical range between support and resistance levels that a stock price has traded in for a specific period of time. Channelling: R.N. Elliott’s description of drawing parallel boundary lines within an impulse pattern to determine support resistance levels for ongoing waves. Climax: A market condition that is characterized by very high trading volume and a dramatic downward or upward movement in price.

High volume and downward price movement indicate a selling climax, while high volume and upward price movement indicate a buying climax. Either type of climax signals the end of a trend. Component A wave that is a constituent part of a larger pattern, e.g. wave A within a zig zag – not to be confused with the ‘subdivision’ of a pattern because that would imply breaking down each of the three waves of a zig zag, A-B-C into minus -1 degree, i.e. 5-3-5. Convergence/Cluster The term used to describe the effect where various fib-price-ratios are applied to differing wave degrees of pattern that results in a convergence of price at one specific area. Corrective wave A three wave pattern, or combination of three wave patterns, which moves in the opposite direction of the prior impulse wave. Corrective waves retrace prior gains or interrupt the primary trend as opposed to motive waves that propel price movement. Corrective waves have a three wave structure or a combination of three waves. They are more difficult to recognize because they come in many variations, such as zigzags, flats, and triangles. They can be strung together to create complex corrections.

In impulse waves 2 and 4, the configuration tends to alternate and not repeat (a zigzag as wave 2 followed by a zigzag for wave 4) for example. If you see a flat as wave 2, a zigzag will appear as wave 4. Convergence theory holds that crowd behavior is not a product of the crowd itself, but is carried into the crowd by particular individuals. Thus, crowds amount to a convergence of like-minded individuals. In other words, while contagion theory states that crowds cause people to act in a certain way, convergence theory says the opposite: that people who wish to act in a certain way come together to form crowds. Crests: The tops of waves are called crests The Crowd: A Study of the Popular Mind (1896), Gustave LeBon, in which the author, a frightened aristocrat, interpreted the crowds of the French Revolution as irrational reversions to animal emotion, and inferred from this that such reversion is characteristic of crowds in general. D a five wave pattern – there are two types (see below) Diagonal (Ending) Ending pattern occurring only in 5th or C waves. Develops into a wedge shape that contains ‘overlap’.

All internal waves subdivide into threes although there are often exceptions. Can exist as two types – ‘contracting’ or ‘expanding’ Diagonal (Leading) Continuation pattern occurring only in 1st or A waves that develops into a wedge shape that contains ‘overlap’. Waves 1-3-5 normally subdivide into five wave sequences, although there are often exceptions. Can exist as two types – ‘contracting’ or ‘expanding’ Double Retracement Follows a 5th wave extension where price retraces the preceding impulse in two stages – first by moving back within the range, normally to where the extension began, secondly by travelling in the direction of the termination of the 5th wave, but briefly into a new price extremity. Double Three Combination of two simple sideways corrective patterns, separated by a wave labelled X. Double Zig Zag Combination of two simple sharp corrective patterns, separated by a wave labelled X.

Economic bubbles: An economic bubble (sometimes referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, a speculative mania or a balloon) is “trade in high volumes at prices that are considerably at variance with intrinsic values”.It could also be described as a trade in products or assets with inflated values. Ralph Nelson Elliott, in the 1930s, discovered what is now called the Elliott Wave Principle. He uncovered thirteen basic patterns or waves that describe how markets trend and reverse on a repetitive basis. By linking the patterns together in different combinations, you can create larger versions of the patterns. In this way, the method is said to be fractal. Each wave is composed of smaller waves, like the tide is composed of advancing and receding waves and those waves are composed of ripples. The technique was meant to forecast turning points in the market averages. The Elliott Wave Principle (or Theory) was developed by Ralph Nelson Elliott in the nineteen twenties. Like many other formulations, the purpose of the Elliott Wave Theory was to create an organizing principle that would explain the otherwise chaotic movement of the stock market.

According to the Elliott Wave Theory, the market fluctuated in a recurring pattern of five upward and three downward moving waves. Equality In a five wave sequence, when wave three is the longest, wave five and wave one tend to be equal in price length and occasionally time. Expanded flat Flat correction where waves B & C enters new price territory relative to the extremity established by wave A. Expanding Impulse A five wave pattern characterised where one of the three impulse subdivisions ‘extends’ (is the extended wave or ‘extension’ – its amplitude measures larger than the other two). Extensions Within a five wave pattern where one impulse wave (1, 3 or 5) measures far greater than the other two – additionally, but not exclusively, the extended wave subdivides into a further five wave sequence of -1 degree to the larger ongoing pattern creating a visual 9 wave sequence. Can also subdivide into -2 degrees to create a 13 wave sequence, and -3 degrees for a 17 wave sequence. An extension is an unusually long wave, composed not of 5 subwaves but 9 (or even more, like 13).

In the 1, 3, or 5 wave sequence, only one of the waves will be an extension. Thus, if wave 1 extends, then waves 3 and 5 will be normal length. If waves 1 and 3 are normal, then look for a long move on wave 5. Extraordinary Popular Delusions and the Madness of Crowds, Charles Mackay, first published in 1841, The book chronicles its subjects in three parts: “National Delusions”, “Peculiar Follies”, and “Philosophical Delusions”. Despite its journalistic and rather sensational style, the book has gathered a body of academic support as a work of considerable importance in the history of social psychology and psychopathology. F Failure Fetch: Wave energy is dependent on weather conditions, the length of the waves, wind speed, the duration of the wind, and the distance the wind travels over open water (fetch) see Truncated Fifth Leonardus filius Bonaccii. – Fibonacci Number Sequence Fibonacci was an Italian mathematician from Pisa during the 12th Century. His most important work was the discovery of what is known as the Summation Series.

This sequence of numbers begins as follows: 1,1,2,3,5,8,13,21,34,55,89,144 ad infinitum. Adding the last two numbers together yields the next in the sequence. Dividing any number into the preceding figure yields the decimal 0.618, into the second preceding, 0.382, the third, 0.236. Dividing into the following number yields 1.618 and 2.618. These ratios can be found in many natural living things, such as spirals or shells, measurement of the beats of a human heart, the wing of a butterfly or the electrical oscillations of the brain. The scale and depth of Fibonacci’s discovery cannot be overstated as he recognised a unified sequence of ratios governing growth and decay that underlies all natural phenomena. The use of Fib-Price-Ratios applied to the Elliott Wave Principle break down into three main categories – ‘extension’, ‘correlative’ & ‘retracement’ ratios.

Extension ratios are used for measuring price activity that projects beyond an existing high-low range – examples of use are for projecting target levels for wave 5 within an impulse pattern or wave C within a zig zag. Correlative ratios are used to compare the amplitude of two (or more) separate wave sequences within a larger progressive pattern – examples would be waves 1& 5 of an impulse pattern measuring to equality, 100%, and waves A & C of a zig zag. Retracement ratios are used to determine the partial contraction of a particular wave of its immediate predecessor. The most common Fib-Price Ratios are 14.58%, 23.6%, 38.2%, 61.8%, 76.4%, 100%, 114.5%, 123.6%, 138.2% & 161.8%. (see an example of how these ratios are applied). Flat Horizontal sideways correction, labelled A-B-C, parrallel highs & lows Fourth wave preceding degree (see also Previous Fourth Wave) The fourth wave within the preceding impulse wave of the same degree. Corrective patterns typically terminate in this area.

G Golden Section The Golden Section, also referred to as the ‘Golden Cut’ or ‘Golden mean, is known since antiquity and was taught by Plato and Euclid as the ‘Universal Law of Harmony’. The ‘Golden Section’ is quite remarkable insomuch that it helps distinguish ratio (see Fibonacci Ratio) from proportion. A ratio constitutes a measure of difference – a comparison between two things. A proportion, however, is a relationship of equivalency between two sets of ratios, that is to say, one element is to a second element as the second is to the third. This is accomplished by dividing a line in such a way that – the smaller dimension is to the greater, as the greater is to the whole. The ‘Golden Section’ is widely used in the application of Elliott Wave Theory in order to measure the price objectives of certain patterns. If is applied to the separation line, then three equations are derived – 0.382, 0.618 and 1.00 : 0.382 has the same relationship to 0.618 as 0.618 has to 1.00.

Group Psychology and the Analysis of the Ego (1922), Freud ,Sigmund. H Hierarchy The order and classification of varying degrees of waves that helps to distinguish the relative position of one group from another. I Impulse Wave A five wave pattern with subwaves 5-3-5-3-5 and no overlap between waves one and four. M Market equilibrium a condition where a market price is established through competition such that the amount of goods or services sought by buyers is equal to the amount of goods or services produced by sellers . Mississippi Company Bubble This corporation, which held a business monopoly in French colonies in North America and the West Indies, became one of the earliest examples of an economic bubble. Motive waves are those that propel the market as opposed to corrective ones that retrace prior gains or interrupt the primary trend. Motive waves have a five wave structure or a combination of a five wave structure. They obey the rules that subwave 4 will not overlap subwave 1, and subwave 3 is not the shortest wave. Wave 2 will not retrace all of wave 1, and wave 4 will not retrace all of wave 3.

Wave 3 always travels beyond the end of wave 1. Wave 3 is often the longest wave of waves 1 and 5. Motive waves often follow a trend channel — two roughly parallel lines of trend. One of the subwaves, 1, 3, or 5, is usually longer (extended) than the others. N Nomenclature: A system for the labelling and assigning of numbers and letters to wave patterns. O One-two, one-two The initial development in a five wave pattern, just prior to acceleration – this is nothing other than the ‘extended’ wave of an impulse that begins fractalistaion – subdivides into a series of smaller 1-2 sequences prior to an expanding 3rd wave.

The extended wave can fractalise into additional subdivisions (1-2, 1-2 is -1 degree of trend [9 wave pattern sequence] – 1-2, 1-2, 1-2 is -2 degrees [13 wave pattern sequence] – 1-2, 1-2, 1-2, 1-2 is -3 degress [17 wave pattern sequence]) Can be found developing in 1st, 3rd & 5th waves One degree higher If you were a wave of water, then a wave of one higher degree would be the tide. On the price chart, if you were a subwave, then a wave would be one degree higher. Think of it like a camera. If you zoom in, you see the subwaves. When you zoom out, you see the waves. Overlap The incursion of wave four into the price territory of wave one. Not permitted in an ‘expanding’ five wave impulse pattern but is a prerequiste for the ‘diaognal’ five wave impulse pattern. When wave four moves into the territory of wave one. By definition, this cannot happen in an impulse wave.

P Pattern A composition of singular waves that form into specific and recognisable patterns that R.N.Elliott discovered repeating in the financial markets. There are currently 13 archetypal patterns in the archive list of WaveSearch. Pattern-Centric Views a complete Elliott Wave pattern as an aggregate/whole, e.g. zig zag or diagonal. It is the viewpoint from which to begin analysing and comparing differing patterns – see WaveSearch. Permutation Specifically refers to the variable patterns a component wave can unfold into within a larger aggregate pattern – e.g. wave A of a zig zag must subdivide into a five wave sequence and so this can unfold into these varying possibilities – expanding impulse 1st extension, 3rd extension, 5th extension, diagonal leading-contracting, diagonal leading-expanding (totalling 5 permutations). Preferential Count The primary assessment of wave pattern that complies mostly to the various rules and guidelines of The Wave Principle. Previous Fourth Wave The fourth wave within the preceding impulse wave of the same degree. Corrective patterns typically terminate in this area.

Proportion The comparative relationship between ratios – in EW terms, this creates a harmonious convergence of price where varying degrees of pattern ratios come together to form a singular point – e.g. a zig zag is a counter-trend pattern comprising of waves A-B-C, subdividing 5-3-5 – extending wave A by a fib. 61.8% ratio projects the terminal conclusion for wave C converging towards an exact Fibonacci resistance level measured from the pattern of one higher degree, whilst measuring the five wave subdivisions of wave C of one lower degree also converge to the same price level. R Ratio The measurement relationship between two waves, e.g. fib. 100% equality between waves A & C within a zig zag pattern. Each wave exhibits varying ratio measurements to another depending on its relative location as the ‘component’ within its larger ‘aggregate’ counterpart – see WaveSearch for details. Rip current is water that flows straight back out to sea after its waves have broken on the beach. These currents are most prominent immediately after a large set of waves has broken and tend to develop where wave heights are lower. They flow quickly back through the surf zone and dissipate in the open ocean.

Running Flat Sideways correction, labelled A-B-C but wave C ends inside trading range of wave B estblishing a ‘truncation’ (unlike the expanding flat, wave C cannot end beyond the price extreme established by wave A) John Scott Russell In 1834, while conducting experiments to determine the most efficient design for canal boats, he discovered a phenomenon that he described as the wave of translation. S Sharp Correction Any corrective pattern which does not contain a new price extreme relative to the prior impulse wave; alternates with sideways correction. Sideways Correction Any corrective pattern which contains a new price extreme relative to the prior impulse wave; alternates with sharp correction. South Sea Bubble Company stock rose greatly in value as it expanded its operations dealing in government debt, peaking in 1720 before collapsing to little above its original flotation price; this became known as the South Sea Bubble. A subwave is the smaller price movements that make up a wave. If you were a wave of water, then a subwave would be a ripple. If you were a camera, you would zoom in to see the subwaves and zoom out to see the waves. Surf is that zone where waves break against the shoreline.

SWELL is the term used to describe well-sorted, uniform, long waves. Swash: sheet of water that sweeps up the slope of the beach. Troughs are the lowest points of the wave. Throw-over: Action attributed to wave five within a diagonal where it briefly penetrates the boundary line established by waves 1 and 3 before staging a reversal. Thrust: Sharp movement following completion of a triangle. Triangle: (contracting, ascending, descending and expanding) – Corrective pattern, labelled a-b-c-d-e. Occurs as 4th, B or X wave. Prices converge/diverge as pattern progresses. Triple Three: Combination of three simple sideways corrective patterns, separated by a wave labelled X. Triple Zig Zag: Combination of three simple sharp corrective patterns, separated by a wave labelled X. Truncated Fifth: Pattern in which the fifth wave fails to exceed the price extreme of the third wave – also applies to wave C within a running flat. Tulip mania or tulipomania was a period in the Dutch Golden Age during which contract prices for bulbs of the recently introduced tulip reached extraordinarily high levels and then suddenly collapsed.

By 1636 the tulip bulb became the fourth leading export product of the Netherlands—after gin, herring and cheese. The price of tulips skyrocketed because of speculation in tulip futures among people who never saw the bulbs. Many men made and lost fortunes overnight. U V Volume A condition where volume normally diminishes in a fifth wave than compared to wave three. If higher in wave five, may indicate the propensity for ‘extension’. W Wave The singular movement of price action – the term used to describe the components of an Elliott Wave pattern – “the passage of undulating motion…a single curve in the course of this motion”. They form as the components of a larger ‘aggregate’ pattern, whilst themselves contain smaller component waves that means each wave is itself a pattern in its own right. Wave-Centric Views all waves as separate sequences as parts of a greater aggregate/whole, or EW pattern. They annotate as follows: 1-2-3-4-5-A-B-C-D-E-W-X-Y-Z. It is the viewpoint from which to begin analysing and comparing differing waves – see WaveSearch. Wave height: The tops of waves are called crests and are separated by the lowest points, called troughs.

The most powerful waves have the greatest wave height. Wave height is the vertical distance between the crest and the trough. Normal waves can be nearly 5 meters (15 feet) high; severe tropical storms can generate waves up to 15 meters (50 feet) high. Wavelength: The wavelength is the horizontal distance between two adjacent crests or two adjacent troughs. Typical wavelengths vary from about 30 to 300 meters (100−1,000 feet), and waves move at speeds up to 50 miles per hour. The depth of the wave motion is about half the wavelength; for example, if the wavelength is about 150 meters, 75 meters below the wave crest the water is calm. Wave movement: At the surface of the wave, a water particle moves in a roughly circular, vertical orbit; the radius of the orbit is equal to about half the wave height. During the passing of the wave, the water particle follows a circular path and returns to its original position after the wave has passed. The deeper the water particle is from the surface of the ocean, the smaller is its orbit. Water particles at depths greater than half the wavelength have essentially no motion generated by surface waves.

Waves of oscillation: Waves in the open sea are called waves of oscillation because of this orbital motion. The circular orbits of water molecules are flattened into oval patterns as the wave approaches the shallow water near the shore. Friction with the bottom begins to slow the wave down, and the upward slope of the bottom pushes the water upward to form higher waves. Wave of translation a wave in which the particles of water move forward in the direction of wave propagation. Wave Refraction: Waves generally approach the shore at an angle. The end of the angled wave closest to shore reacts to the decreasing depth by slowing, while the other end of the wave continues at full speed. Consequently, as the depth decreases, the wave crest bends to become more parallel with the shore. WaveSearch WaveTrack’s Elliott Wave tutorial tool listing all waves and patterns that comprise the Elliott Wave Principle. It has an archive of several thousand archived tutorial patterns and contains several hundred historical archived patterns. It specialised in the application of Ratio & Proportion relationships for each pattern. It is interactive software for the user to search, analyse and learn from the differing characteristics of Elliott Waves and Patterns. Wedge Shape Patterns Wedge Shape Patterns also known as Diagonal Pattern (see Diagonal Patterns).

Economic bubble - WikiVisually FEATURED ARTICLES · CHANGE LANGUAGE · hover over links in text for more info click links in text for more info Economic bubble Jump to: navigation , search An economic bubble or asset bubble (sometimes also referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, a speculative mania, or a balloon) is trade in an asset at a price or price range that strongly deviates from the corresponding asset's intrinsic value . [1] [2] [3] It could also be described as a situation in which asset prices appear to be based on implausible or inconsistent views about the future. [4] Asset bubbles date back as far as the 1600s and are now widely regarded as a recurrent feature of modern economic history. [5] Because it is often difficult to observe intrinsic values in real-life markets, bubbles are often conclusively identified only in retrospect, once a sudden drop in prices has occurred. Such a drop is known as a crash or a bubble burst. Both the boom and the burst phases of the bubble are examples of a positive feedback mechanism, in contrast to the negative feedback mechanism that determines the equilibrium price under normal market circumstances.

Prices in an economic bubble can fluctuate erratically, and become impossible to predict from supply and demand alone. While some economists deny that bubbles occur, [6] [ page needed ] the cause(s) of bubbles remains disputed by those who are convinced that asset prices often deviate strongly from intrinsic values. Many explanations have been suggested, and research has recently shown that bubbles may appear even without uncertainty , [7] speculation , [8] or bounded rationality . [9] In such cases, the bubbles may be argued to be rational, where investors at every point are fully compensated for the possibility that the bubble might collapse by higher returns. These approaches require that the timing of the bubble collapse can only be forecast probabilistically and the bubble process is often modelled using a Markov switching model. [10] [11] Similar explanations suggest that bubbles might ultimately be caused by processes of price coordination. [12] More recent theories of asset bubble formation suggest that these events are sociologically driven. For instance, explanations have focused on emerging social norms [9] and the role that culturally-situated stories or narratives play in these events.

[5] Contents A card from the South Sea Bubble The term "bubble", in reference to financial crisis, originated in the 1711–1720 British South Sea Bubble , and originally referred to the companies themselves, and their inflated stock, rather than to the crisis itself. This was one of the earliest modern financial crises; other episodes were referred to as "manias", as in the Dutch tulip mania . The metaphor indicated that the prices of the stock were inflated and fragile – expanded based on nothing but air, and vulnerable to a sudden burst, as in fact occurred. Some later commentators have extended the metaphor to emphasize the suddenness, suggesting that economic bubbles end "All at once, and nothing first, / Just as bubbles do when they burst," [13] though theories of financial crises such as debt-deflation and the Financial Instability Hypothesis suggest instead that bubbles burst progressively, with the most vulnerable (most highly- leveraged ) assets failing first, and then the collapse spreading throughout the economy. Impact[ edit ] The impact of economic bubbles is debated within and between schools of economic thought ; they are not generally considered beneficial, but it's debated how harmful their formation and bursting is.

Within mainstream economics , many believe that bubbles cannot be identified in advance, cannot be prevented from forming, that attempts to "prick" the bubble may cause financial crisis , and that instead authorities should wait for bubbles to burst of their own accord, dealing with the aftermath via monetary policy and fiscal policy . Within Austrian economics , economic bubbles are generally considered to have a negative impact on the economy because they tend to cause misallocation of resources into non-optimal uses; this forms the basis of Austrian business cycle theory . Political economist Robert E. Wright argues that bubbles can be identified before the fact with high confidence. [14] In addition, the crash which usually follows an economic bubble can destroy a large amount of wealth and cause continuing economic malaise; this view is particularly associated with the debt-deflation theory of Irving Fisher , and elaborated within Post-Keynesian economics . A protracted period of low risk premiums can simply prolong the downturn in asset price deflation as was the case of the Great Depression in the 1930s for much of the world and the 1990s for Japan . Not only can the aftermath of a crash devastate the economy of a nation, but its effects can also reverberate beyond its borders.

Effect upon spending[ edit ] Another important aspect of economic bubbles is their impact on spending habits. Market participants with overvalued assets tend to spend more because they "feel" richer (the wealth effect ). Many observers quote the housing market in the United Kingdom , Australia , New Zealand , Spain and parts of the United States in recent times, as an example of this effect. When the bubble inevitably bursts, those who hold on to these overvalued assets usually experience a feeling of reduced wealth and tend to cut discretionary spending at the same time, hindering economic growth or, worse, exacerbating the economic slowdown. In an economy with a central bank, the bank may therefore attempt to keep an eye on asset price appreciation and take measures to curb high levels of speculative activity in financial assets.[ citation needed ] This is usually done by increasing the interest rate (that is, the cost of borrowing money). (Historically, this is not the only approach taken by central banks. It has been argued [15] that they should stay out of it and let the bubble, if it is one, take its course.) Possible causes[ edit ] In the 1970s, excess monetary expansion after the U.S.

came off the gold standard (August 1971) created massive commodities bubbles. These bubbles only ended when the U.S. Central Bank (Federal Reserve) finally reined in the excess money, raising federal funds interest rates to over 14%.[ citation needed ] The commodities bubble popped and prices of oil and gold, for instance, came down to their proper levels. Similarly, low interest rate policies by the U.S. Federal Reserve in the 2001–2004 are believed to have exacerbated housing and commodities bubbles. The housing bubble popped as subprime mortgages began to default at much higher rates than expected, which also coincided with the rising of the fed funds rate . It has also been variously suggested that bubbles may be rational, [16] intrinsic, [17] and contagious. [18] To date, there is no widely accepted theory to explain their occurrence. [5] Recent computer-generated agency models suggest excessive leverage could be a key factor in causing financial bubbles. [19] Puzzlingly for some, bubbles occur even in highly predictable experimental markets, where uncertainty is eliminated and market participants should be able to calculate the intrinsic value of the assets simply by examining the expected stream of dividends.

[7] Nevertheless, bubbles have been observed repeatedly in experimental markets, even with participants such as business students, managers, and professional traders. Experimental bubbles have proven robust to a variety of conditions, including short-selling, margin buying, and insider trading. [5] [1] While there is no clear agreement on what causes bubbles, there is evidence[ citation needed ] to suggest that they are not caused by bounded rationality or assumptions about the irrationality of others, as assumed by greater fool theory . It has also been shown that bubbles appear even when market participants are well-capable of pricing assets correctly. [9] Further, it has been shown that bubbles appear even when speculation is not possible [8] or when over-confidence is absent. [9] More recent theories of asset bubble formation suggest that they are likely sociologically-driven events, thus explanations that merely involve fundamental factors or snippets of human behavior are incomplete at best. For instance, qualitative researchers Preston Teeter and Jorgen Sandberg argue that market speculation is driven by culturally-situated narratives that are deeply embedded in and supported by the prevailing institutions of the time.

[5] They cite factors such as bubbles forming during periods of innovation, easy credit, loose regulations, and internationalized investment as reasons why narratives play such an influential role in the growth of asset bubbles. Liquidity[ edit ] One possible cause of bubbles is excessive monetary liquidity in the financial system, inducing lax or inappropriate lending standards by the banks , which makes markets vulnerable to volatile asset price inflation caused by short-term, leveraged speculation. [19] For example, Axel A. Weber , the former president of the Deutsche Bundesbank , has argued that "The past has shown that an overly generous provision of liquidity in global financial markets in connection with a very low level of interest rates promotes the formation of asset-price bubbles." [20] According to the explanation, excessive monetary liquidity (easy credit, large disposable incomes) potentially occurs while fractional reserve banks are implementing expansionary monetary policy (i.e. lowering of interest rates and flushing the financial system with money supply); this explanation may differ in certain details according to economic philosophy.

Those who believe the money supply is controlled exogenously by a central bank may attribute an 'expansionary monetary policy' to said bank and (should one exist) a governing body or institution; others who believe that the money supply is created endogenously by the banking sector may attribute such a 'policy' with the behavior of the financial sector itself, and view the state as a passive or reactive factor. This may determine how central or relatively minor/inconsequential policies like fractional reserve banking and the central bank's efforts to raise or lower short-term interest rates are to one's view on the creation, inflation and ultimate implosion of an economic bubble. Explanations focusing on interest rates tend to take on a common form, however: When interest rates are set excessively low, (regardless of the mechanism by which it is accomplished) investors tend to avoid putting their capital into savings accounts. Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as stocks and real estate . Risky leveraged behavior like speculation and Ponzi schemes can lead to an increasingly fragile economy, and may also be part of what pushes asset prices artificially upward until the bubble pops.

But these [ongoing economic crises] aren’t just a series of unrelated accidents. Instead, what we’re seeing is what happens when too much money is chasing too few investment opportunities. Paul Krugman [21] Simply put, economic bubbles often occur when too much money is chasing too few assets, causing both good assets and bad assets to appreciate excessively beyond their fundamentals to an unsustainable level. Once the bubble bursts, the fall in prices causes the collapse of unsustainable investment schemes (especially speculative and/or Ponzi investments, but not exclusively so), which leads to a crisis of consumer (and investor) confidence that may result in a financial panic and/or financial crisis; if there is monetary authority like a central bank, it may be forced to take a number of measures in order to soak up the liquidity in the financial system or risk a collapse of its currency. This may involve actions like bailouts of the financial system, but also others that reverse the trend of monetary accommodation, commonly termed forms of 'contractionary monetary policy'.

Some of these measures may include raising interest rates, which tends to make investors become more risk averse and thus avoid leveraged capital because the costs of borrowing may become too expensive; others may include certain countermeasures that may be taken pre-emptively during periods of strong economic growth include having the central monetary authority increase capital reserve requirements and attempting to implement regulation that checks and/or prevents processes leading to over-expansion and excessive leveraging of debt. Ideally, such countermeasures lessen the impact of a downturn by strengthening financial institutions while the economy is strong. Advocates of perspectives stressing the role of credit money in an economy often refer to (such) bubbles as "credit bubbles," and look at such measures of financial leverage as debt to GDP ratios to identify bubbles. Typically the collapse of any economic bubble results in an economic contraction termed (if less severe) a recession or (if more severe) a depression; what economic policies to follow in reaction to such a contraction is a hotly debated perennial topic of political economy. The importance of liquidity was derived in a mathematical setting [22] and in an experimental setting [23] [24] (see Section "Experimental and mathematical economics").

Social psychology factors[ edit ] Main article: Greater fool theory Greater fool theory states that bubbles are driven by the behavior of a perennially optimistic market participants (the fools) who buy overvalued assets in anticipation of selling it to other speculators (the greater fools) at a much higher price. According to this explanation, the bubbles continue as long as the fools can find greater fools to pay up for the overvalued asset. The bubbles will end only when the greater fool becomes the greatest fool who pays the top price for the overvalued asset and can no longer find another buyer to pay for it at a higher price. This theory is popular among laymen, but has not yet been fully confirmed by empirical research. [8] [9] Clifford Asness [25] Extrapolation is projecting historical data into the future on the same basis; if prices have risen at a certain rate in the past, they will continue to rise at that rate forever. The argument is that investors tend to extrapolate past extraordinary returns on investment of certain assets into the future, causing them to overbid those risky assets in order to attempt to continue to capture those same rates of return.

Overbidding on certain assets will at some point result in uneconomic rates of return for investors; only then the asset price deflation will begin. When investors feel that they are no longer well compensated for holding those risky assets, they will start to demand higher rates of return on their investments. Herding[ edit ] Another related explanation used in behavioral finance lies in herd behavior , the fact that investors tend to buy or sell in the direction of the market trend. [26] [27] This is sometimes helped by technical analysis that tries precisely to detect those trends and follow them, which creates a self-fulfilling prophecy . Investment managers, such as stock mutual fund managers, are compensated and retained in part due to their performance relative to peers. Taking a conservative or contrarian position as a bubble builds results in performance unfavorable to peers. This may cause customers to go elsewhere and can affect the investment manager's own employment or compensation. The typical short-term focus of U.S. equity markets exacerbates the risk for investment managers that do not participate during the building phase of a bubble, particularly one that builds over a longer period of time.

In attempting to maximize returns for clients and maintain their employment, they may rationally participate in a bubble they believe to be forming, as the risks of not doing so outweigh the benefits. [28] Moral hazard[ edit ] Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. A person's belief that they are responsible for the consequences of their own actions is an essential aspect of rational behavior. An investor must balance the possibility of making a return on their investment with the risk of making a loss – the risk-return relationship. A moral hazard can occur when this relationship is interfered with, often via government policy . A recent example is the Troubled Asset Relief Program (TARP), signed into law by U.S. President George W. Bush on 3 October 2008 to provide a Government bailout for many financial and non-financial institutions who speculated in high-risk financial instruments during the housing boom condemned by a 2005 story in The Economist titled "The worldwide rise in house prices is the biggest bubble in history". [29] A historical example was intervention by the Dutch Parliament during the great Tulip Mania of 1637 .

Other causes of perceived insulation from risk may derive from a given entity's predominance in a market relative to other players, and not from state intervention or market regulation. A firm – or several large firms acting in concert (see cartel , oligopoly and collusion ) – with very large holdings and capital reserves could instigate a market bubble by investing heavily in a given asset, creating a relative scarcity which drives up that asset's price. Because of the signaling power of the large firm or group of colluding firms, the firm's smaller competitors will follow suit, similarly investing in the asset due to its price gains. However, in relation to the party instigating the bubble, these smaller competitors are insufficiently leveraged to withstand a similarly rapid decline in the asset’s price. When the large firm, cartel or de facto collusive body perceives a maximal peak has been reached in the traded asset's price, it can then proceed to rapidly sell or "dump" its holdings of this asset on the market, precipitating a price decline that forces its competitors into insolvency, bankruptcy or foreclosure.

The large firm or cartel – which has intentionally leveraged itself to withstand the price decline it engineered – can then acquire the capital of its failing or devalued competitors at a low price as well as capture a greater market share (e.g., via a merger or acquisition which expands the dominant firm's distribution chain). If the bubble-instigating party is itself a lending institution, it can combine its knowledge of its borrowers’ leveraging positions with publicly available information on their stock holdings, and strategically shield or expose them to default. Other possible causes[ edit ] Some regard bubbles as related to inflation and thus believe that the causes of inflation are also the causes of bubbles. Others take the view that there is a "fundamental value" to an asset , and that bubbles represent a rise over that fundamental value, which must eventually return to that fundamental value. There are chaotic theories of bubbles which assert that bubbles come from particular "critical" states in the market based on the communication of economic factors. Finally, others regard bubbles as necessary consequences of irrationally valuing assets solely based upon their returns in the recent past without resorting to a rigorous analysis based on their underlying "fundamentals" .

Net Result of a Bubble: The one true constant with all bubbles is that they create excess demand and production. Once the bubble deflates, which it always does, a contraction or consolidation has to occur to alleviate the excess. Two examples are the dot-com bubble and the current housing bubble. In both cases there were huge consolidations, bankruptcies, and deterioration of asset values. Experimental and mathematical economics[ edit ] Bubbles in financial markets have been studied not only through historical evidence, but also through experiments , mathematical and statistical works. Smith, Suchanek and Williams [7] designed a set of experiments in which an asset that gave a dividend with expected value 24 cents at the end of each of 15 periods (and were subsequently worthless) was traded through a computer network. Classical economics would predict that the asset would start trading near $3.60 (15 times $0.24) and decline by 24 cents each period. They found instead that prices started well below this fundamental value and rose far above the expected return in dividends. The bubble subsequently crashed before the end of the experiment. This laboratory bubble has been repeated hundreds of times in many economics laboratories in the world, with similar results.

The existence of bubbles and crashes in such a simple context was unsettling for the economics community that tried to resolve the paradox on various features of the experiments. To address these issues Porter and Smith [30] and others performed a series of experiments in which short selling, margin trading, professional traders all led to bubbles a fortiori. Much of the puzzle has been resolved through mathematical modeling and additional experiments. In particular, starting in 1989, Gunduz Caginalp and collaborators [22] [31] modeled the trading with two concepts that are generally missing in classical economics and finance. First, they assumed that supply and demand of an asset depended not only on valuation, but on factors such as the price trend. Second, they assumed that the available cash and asset are finite (as they are in the laboratory). This is contrary to the “infinite arbitrage” that is generally assumed to exist, and to eliminate deviations from fundamental value. Utilizing these assumptions together with differential equations, they predicted the following: (a) The bubble would be larger if there was initial undervaluation.

Initially, “value-based” traders would buy the undervalued asset creating an uptrend, which would then attract the “momentum” traders and a bubble would be created. (b) When the initial ratio of cash to asset value in a given experiment was increased, they predicted that the bubble would be larger. An epistemological difference between most microeconomic modeling and these works is that the latter offer an opportunity to test implications of their theory in a quantitative manner. This opens up the possibility of comparison between experiments and world markets. These predictions were confirmed in experiments [23] [24] that showed the importance of “excess cash” (also called liquidity, though this term has other meanings), and trend-based investing in creating bubbles. When price collars were used to keep prices low in the initial time periods, the bubble became larger. In experiments in which L= (total cash)/(total initial value of asset) were doubled, the price at the peak of the bubble nearly doubled. This provided valuable evidence for the argument that “cheap money fuels markets.” Caginalp's asset flow differential equations provide a link between the laboratory experiments and world market data.

Since the parameters can be calibrated with either market, one can compare the lab data with the world market data. The asset flow equations stipulate that price trend is a factor in the supply and demand for an asset that is a key ingredient in the formation of a bubble. While many studies of market data have shown a rather minimal trend effect, the work of Caginalp and DeSantis [32] on large scale data adjusts for changes in valuation, thereby illuminating a strong role for trend, and providing the empirical justification for the modeling. The asset flow equations have been used to study the formation of bubbles from a different standpoint in [33] where it was shown that a stable equilibrium could become unstable with the influx of additional cash or the change to a shorter time scale on the part of the momentum investors. Thus a stable equilibrium could be pushed into an unstable one, leading to a trajectory in price that exhibits a large “excursion” from either the initial stable point or the final stable point. This phenomenon on a short time scale may be the explanation for flash crashes. Identifying asset bubbles[ edit ] CAPE based on data from economist Robert Shiller's website, as of 8/4/2015.

The 26.45 measure was 93rd percentile, meaning 93% of the time investors paid less for stocks overall relative to earnings. Economic or asset price bubbles are often characterized by one or more of the following: Unusual changes in single measures, or relationships among measures (e.g., ratios) relative to their historical levels. For example, in the housing bubble of the 2000s, the housing prices were unusually high relative to income. [34] For stocks, the price to earnings ratio provides a measure of stock prices relative to corporate earnings; higher readings indicate investors are paying more for each dollar of earnings. [35] Elevated usage of debt (leverage) to purchase assets, such as purchasing stocks on margin or homes with a lower down payment. Higher risk lending and borrowing behavior, such as originating loans to borrowers with lower credit quality scores (e.g., subprime borrowers), combined with adjustable rate mortgages and "interest only" loans. Rationalizing borrowing, lending and purchase decisions based on expected future price increases rather than the ability of the borrower to repay.

[36] Rationalizing asset prices by increasingly weaker arguments, such as "this time it's different" or "housing prices only go up." A high presence of marketing or media coverage related to the asset. [5] Incentives that place the consequences of bad behavior by one economic actor upon another, such as the origination of mortgages to those with limited ability to repay because the mortgage could be sold or securitized, moving the consequences from the originator to the investor. International trade ( current account ) imbalances, resulting in an excess of savings over investments, increasing the volatility of capital flow among countries. For example, the flow of savings from Asia to the U.S. was one of the drivers of the 2000s housing bubble. [37] A lower interest rate environment, which encourages lending and borrowing. [38] Examples of bubbles and purported bubbles[ edit ]

Question: With examples such as tulip, South Sea company, and .com, what is the name for the economic condition characterized by "trade in high volumes at prices that are considerably at variance with intrinsic values"?
Answer: Bubble